High-quality companies outside the U.S. look especially attractive to us. And their stocks have underperformed recently, possibly giving them greater upside potential.

On June 22, 2020, we issued a paper entitled Opportunities Outside the United States—which assesses the status of small- and mid-cap companies in international developed and emerging markets. Our conclusion is that stocks in these markets have generally underperformed their U.S. counterparts for more than five years. But we believe business-quality measures are generally better outside the United States.

Moreover, we think the four Wasatch international and emerging markets strategies that are discussed in the paper stack up especially well in terms of quality. This combination of modest performance in the recent past and attractive business-quality fundamentals gives us optimism for these strategies going forward.

In this Market Scout, we summarize the main points from Opportunities Outside the United States. For the full paper, please visit the News & Insights section at wasatchglobal.com. We begin with the performance of stocks as categorized by various benchmark indexes. Then we present what we consider to be one of the most important measures of business quality—EBIT ROA. We also show how the four Wasatch international and emerging markets strategies compare to their benchmarks in terms of EBIT ROA.

STOCK PERFORMANCE DURING THE PAST SEVERAL YEARS

Starting with the United States, we note that U.S. small caps (as represented by the Russell 2000® Index) have underperformed U.S. large caps (as represented by the S&P 500® Index) during the past several years. This underperformance is evident in Figure 1 below.

Figure 1

Not only have U.S. small caps lagged U.S. large caps, but they’ve experienced the worst of both worlds—generally performing less robustly in the rising environment before the Covid-19 pandemic and more poorly in the falling environment after the pandemic began. For the 2020 year-to-date period through June 30, U.S. small caps were still lagging large caps—even after the rebound from the trough of the Covid-related selloff.

Like U.S. small caps, international small caps have shown disappointing returns. Among the other categories of stocks presented in Figure 1, the returns have been progressively worse: emerging markets mid to large caps, then international mid to large caps, and finally emerging markets small caps trailing them all. For the entire period of five years and six months—leading up to and including the Covid-19 pandemic—Figure 1 shows the respective cumulative and annualized total returns in order of best to worst.

Think about these numbers for a moment. In this span of five years and six months, emerging markets small caps, for example, have made only about 1% cumulatively—which is less than 0.2% on an annualized basis.